Philadelphia Fed’s Charles Plosser on federal funds rate guidance

Charles Plosser voted against the July FOMC policy motion

Philadelphia Fed Chief, Dr. Charles Plosser has criticized the Fed’s monetary stimulus program. Dr. Plosser is part of this year’s Federal Open Market Committee (or FOMC). He votes on monetary policy. Out of the ten participants at the July FOMC meeting, Dr. Plosser was the only one who voted against the policy action.

The July FOMC statement indicated that it will likely be appropriate to maintain the current target range for the federal funds rate for “a considerable time after the asset purchase program ends.” Dr. Plosser disagreed with the policy statement because the language was dependent on time. It also didn’t reflect the “substantial progress” that was made towards the Fed’s employment and inflation goals (refer to Part 5).

The use of Taylor-like rules

Dr. Plosser is a keen advocate of using rule-based policy making for the Fed’s monetary policy or setting the federal funds rate. He believes that the Fed should provide transparent rules-based guidance based on Taylor-like rules.

Taylor rules use economic data to determine the base interest rate or the federal funds rate. These rules are becoming increasingly popular among central bankers around the world. For more on the use of Taylor rules and Dr. Plosser’s views on transparency and communication of the Fed’s monetary policy, you can read the Market Realist series, Determining the Fed’s monetary policy needs a systematic approach.

At the July FOMC he said “the reference to calendar time should be replaced with language that indicates how monetary policy will respond to incoming data.” He also felt that due to the “considerable progress” the recovery has made, the FOMC may be compelled to raise rates sooner than markets anticipated. This outcome could be risky and lead to “unnecessary and disruptive volatility in financial markets, and perhaps in the economy.”

Investor impact

An improving economic outlook can be bullish for stocks. The S&P 500 Index increased by 0.25% after the Fed’s minutes were released.

Popular exchange-traded fund (or ETF) indices that track the stock market include the State Street SPDR S&P 500 ETF (SPY), the SPDR Dow Jones Industrial Average ETF (DIA), and the PowerShares QQQ (QQQ). They track the S&P 500 Index, the Dow Jones Industrial Average, and the NASDAQ-100, respectively.

However, bond yields tend to increase during an upswing. Treasury yields increased after the minutes were released. An increase in yields implies lower bond prices. This affects ETFs like the iShares 20+ Year Treasury Bond ETF (TLT). However, inverse ETFs like the ProShares UltraShort 20+ Year Treasury (TBT) benefit from rising yields.

You can read about the investment opportunities in sovereign bonds issued by other governments in the Market Realist series, An investor’s guide to sovereign risk for pricing bond returns.